Although Indonesia has the world’s largest Muslim population, it trails many other markets in terms of uptake, awareness and product innovation in Islamic capital markets. As of the end of May 2015, only 3.3% of corporate bonds and 11.8% of government bonds by value were sharia-compliant. By contrast, in Malaysia half of all debt issued meets Islamic standards.
According to the Financial Services Authority (OJK), Indonesia’s Islamic capital markets have developed for more than a decade, but remain limited. The OJK and others believe the problem is partly lack of official backing and promotion. While other countries may have smaller Muslim populations, they have governments that have promoted the sector and created a regulatory environment that is conducive to the issuance of relevant securities. Neighbouring Malaysia, for example, offers 12 different tax incentives to support its Islamic financial services industry, the OJK notes.
The OJK has declared 2015 to be the year of sharia-compliant capital markets in order to increase understanding and awareness. In addition, it has issued an Islamic capital markets roadmap that charts the course ahead and outlines steps that should be taken to strengthen regulation, develop new sharia-compliant products, improve human resources and IT development, and aid promotion and education, as well as coordination among government and regulators. This roadmap purports to guide the development of Indonesia’s Islamic capital markets for the next five years.
A Short History
The development of the sub-sector has been many years in the making. In 1997 the first sharia-compliant capital markets product was issued in Indonesia, a mutual fund sold by local financial services firm Danareksa. That was followed by steady progress in product creation, definition and regulation. The Jakarta Islamic Index (JII) was launched in 2000, the National Sharia Board of Indonesian Ulema Council (DSN-MUI) issued sharia-compliant mutual fund guidelines in 2001 and the first sukuk (Islamic bonds) were issued by telecoms firm Indosat in September 2002.
In 2003 the Capital Market and Financial Institution Supervisory Agency (Bapepam-LK, the regulator at the time) and the DSN-MUI signed a memorandum of understanding (MoU) to work on the development of sharia-compliant capital markets. That year the regulator created a unit dedicated to Islamic products, and in 2006 and 2007 it issued criteria for sharia-compliant securities as well as rules for issuing these products. Law No. 19 of 2008 on Sharia Sovereign Bonds was published in 2008, and that year Indonesia sold its first sovereign issue of sukuk.
In 2011 the DSN-MUI issued Fatwa No. 80 regarding the implementation of sharia principles in the trading mechanism of equities in the regular market. This decree emphasises that stock trading on the regular market is permissible as long as transactions prohibited by sharia law are avoided. These included front running, misleading information, wash sales, pre-arranged trades, pump and dump, hype and dump, creating fake demand and supply, interest pooling, cornering, marking at close, alternate trade, insider trading, short selling and margin trading.
The Indonesian Stock Exchange introduced the Indonesia Sharia Stock Index (ISSI) in 2011 (the JII is still published). The new index included 214 stocks at its inception – more than half the shares on the exchange at the time – avoiding those firms that are involved in excessive risk-taking, gambling, speculation and the payment of interest. Banks and firms making alcoholic products are excluded as well. The index was launched in the hope that it would increase interest in sharia-compliant stocks and boost their liquidity.
Some big names are included in the index, such as Astra and Indofood CBP Sukses Makmur. The launch of ISSI was followed by the introduction of sharia online trading system, which facilitates trading for sharia investors as it only contains sharia stocks.
The Islamic sector is not separate from the rest of the market. According to the OJK, it exists within the framework of overall sector legislation. “The sharia capital market is not a separate system to the capital market system as a whole,” writes the OJK. “In general, sharia capital market activity is no different from the conventional capital markets, but there are some special characteristics of sharia capital markets.”
Observers say companies do not always understand Islamic finance, how it works and how it relates to them. Some are surprised to find that they are on the ISSI, even though they run their businesses in a sharia-compliant manner. Potential investors in the shares, meanwhile, do not always know the significance of Islamic stocks and do not know how they work relative to others’ shares. Even thought the overwhelming majority of Indonesians are Muslim, many people do not realise the importance of sharia to finance. US-based international law firm K&L Gates notes in a report on the sub-sector that Indonesians tend to be pragmatic in their approach to sharia-compliant finance. In terms of banking services, they will often to go to an Islamic window rather than to a purely Islamic bank. The law firm believes that the country may have reached its limits in terms of people who place sharia compliance above all other considerations, and new customers will generally evaluate conventional finance equally alongside Islamic finance.
The other key issue in the growth of Islamic finance is the simple lack of financial penetration and financial literacy in the country in general. Less than one-third of people in Indonesia have bank accounts and less than 1% have capital markets products of any kind. In certain respects, the spread of Islamic finance is limited because all finance in Indonesia is limited. In a country like Malaysia, where more than 60% of the population has a bank account, Islamic finance has a better chance of reaching more people.
Despite the lack of awareness and the small size of the market, Islamic finance in Indonesia is seen as having significant potential. By some measures, it is the fastest-growing Islamic finance market in the world. According to a 2015 article by Bloomberg, Indonesia has issued more sukuk – $5bn over the past four years – than Malaysia ($3.25bn) or Qatar ($2bn). Malaysia has about five times the total outstanding, but the rate of growth is slower.
As with most of Indonesia’s financial products, those that are sharia-compliant experienced a significant uptick in interest in late 2014 and early 2015 as the economy stabilised and as fear of US Federal Reserve tapering diminished. A $1.5bn sukuk sold in September 2014 generated the largest order book ever for a South-east Asian sukuk, driving the yield down from the 4.625% of the previous issue to 4.35%.
In early 2015 the government sold Rp20trn ($1.7bn) of sukuk to retail investors, with a three-year maturity and a coupon of 8.25%. Demand for the securities was high, according to local press. The hope is that this issuance will attract more capital away from deposit accounts and into the local sukuk market, helping to reduce the dependence on foreign investors, according to Indonesia-Investments website. The government also believes that the sale will help increase the awareness of sukuk among retail investors.
On the supply side, Indonesia is also making efforts. It is, for example, thinking about widening the definition of what can be used for collateral. All sharia-compliant instruments need to be backed by something real, and currently Indonesia focuses on the utilisation of infrastructure to act as the underlying asset for its Islamic paper. The Ministry of Finance said in early 2015 that it would like to see more of the country’s goods and services be used as collateral in order to increase the size of the market.
The government is highly motivated to develop the sub-sector. If Islamic capital markets products were more abundant and better appreciated, they could contribute significantly to the sustainable growth of the economy, according to comments made by Bambang Brodjonegoro, the minister of finance, in April 2015. Because sukuk are still usually backed by infrastructure, the raising of money via these instruments helps the country develop the assets it needs.
The regulatory environment is evolving fast. The OJK says it is planning on issuing six sharia-compliant capital markets regulations to help the development of Islamic finance, which are scheduled to be released in 2015. It is also planning to discuss with the central bank the possibility of the establishment of a short-term sukuk market. This would create more liquidity for Islamic investors.
In 2014 the OJK (which replaced Bapepam-LK in January 2013) signed a new MoU with the DSN-MUI. This one is focused on enhancing the regulation of Islamic financial services, improving financial literacy and protecting the consumer. A cooperation agreement is to follow the MoU, according to a report by K&L Gates. By the end of 2014, the DSN-MUI had issued a total of 14 fatwas (Islamic rulings) pertaining to Islamic capital markets. The K&L Gates report says the country is moving towards a centralised model of sharia compliance, rather than towards the practice of allowing institutions to create their own standards internally.
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